Iceland’s Sovereign Money Proposal – Part 2

In Part 1, I briefly outlined the Sovereign Money System proposal (SMS) advanced by the Icelandic government as a way forward in banking reform. I also demonstrated that the banking collapse in Iceland in 2008 could hardly be seen as being caused by the banks having the capacity to create credit. Much more was in play including the fact that banks had stopped behaving as banks and were serving the doubtful aspirations of their owners rather than any notion of public purpose. While the Icelandic report claims that the commercial bank lending destabilised the growth cycle in Iceland the reality is that it was other factors that led to the explosion of their balance sheets. The money supply did expand faster than “was required to support economic growth” but that is because the financial system was deregulated and the banksters and fraudsters were allowed to serve their own interests and compromise the national interest. As we will see that sort of duplicity can be reigned in with appropriate structural regulation without scrapping the capacity of the private banks to create credit. In this Part 2, I consider some of the mechanics of the SMS and argue that essentially we cannot get away from the fact that a central bank always has to fully fund a monetary system. If it tries to restrict funds yet maintain private bank lending then recession would surely follow and interest rates would rise beyond the control of the central bank. I also provide some ideas on where more fundamental monetary system reform is currently needed.

The Sovereign Money Proposal – flawed paradigm underpinnings

The SMS report is written in the context of an erroneous belief that the national government is ‘financially constrained’.

We see that when it claims that:

By delegating the creation of money to private commercial banks, the Central Bank of Iceland, and thereby the state, foregoes considerable income that it would otherwise earn from creating new money to accommodate economic growth.

First, banks do not have to be profit-making if they are publicly-owned and motivated to serve the public interest.

Second, there is a curious anomaly in the proposal in that it appears to be okay for the private banks to leverage profits from the ‘money’ created by the state (more of which later) but not from credit. I fail to see why we should make that distinction.

Third, and more importantly (to ensure this discussion doesn’t hinge on the ownership status of the banks), a national government and its central bank does not need income in order to spend the currency of issue.

It is simply a nonsense to worry about ‘income lost’ when considering the operations of a currency-issuing government.

We also see it when the Report claims the government has to “guarantee bank deposits” under the current system. This is alleged to promote ‘moral hazard’ – risky lending. Again this is really a regulative matter of limiting what banks can do with the assets creates.

It makes much more sense to regulate the asset side of the bank rather than the liability side.

This should also mean that the government should ensure the banks observe their ‘public’ responsibilities to advance public interest. I would ensure that through public ownership.

But it can also be done within a private banking system just as easily through appropriate regulation (see later).

But, the ultimate point the Report makes here is that:

Should any one of them fail, the insurance fund will not suffice to bail out all depositors. In such circumstances, the government will have to step in with taxpayers’ money to guarantee deposits.

The taxpayers use the government’s currency – they do not supply the spending capacity of the government.

A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. The government is always capable of underwriting the deposits in the banking system.

In the case of a private bank failure, the government can always nationalise the bank, eliminate the shareholder interest (as recognition of the loss) and trade on as usual with all deposits intact.

The Sovereign Money Proposal – in brief

The Sovereign Money System (SMS) proposed by the Icelandic report has several features, which are shared with longer-standing positive money type proposals. In the following quotes CBI refers to the Central Bank of Iceland but generalises to any central bank.

First, “money creation and the payments system is separate from the risky investing and lending of banks”. The “private banks do not create money” and “all money, whether physical or electronic, is created by the Central Bank.”

The SMS private bank remains a speculative institution, however. They would offer two types of accounts:

Transaction accounts – Individuals and firms will have “Transaction Accounts” held at the central bank with funds created by the central bank. Banks cannot invest these funds and there is no interest paid on them. They are not liabilities of the banks and therefore their status is independent of the viability of the bank administering them.

Investment accounts – Banks will create “Investment Accounts” for individuals and firms which can accept funds from the Transaction Accounts. If then invested they are like a fixed-term deposit.

The bank makes profits by levying fees on the administration of the Transaction Accounts and by taking speculative positions with funds lodged in the investment accounts. So it is clear, that a bank can become insolvent under this plan if its investment portfolio fails.

The Transaction Accounts are different to the current system in that the funds are not “backed by risk-bearing assets and can only be withdrawn as long as the bank correctly manages its small stock of liquidity”.

In a currency-issuing nation, however, there is no fundamental improvement. Depositors’ funds are safe irrespective if the government is of that will.

However, in the SMS, the depositor is unable to earn interest on their savings unless they expose the funds to risk via lodgements to bank Investment Accounts.

Individuals will have to pay the banks (fees) to lodge their savings in Transaction Accounts. There is no change there as most banks currently levy account keeping fees.

Second, while the “commercial banks will no longer create money, they will continue to administer payments services for customers and will make loans by acting as intermediaries between savers and borrowers”. The Investment Accounts serve this purpose.

The banks will compete for custom and offer interest to those who wish to transfer funds from their Transaction Accounts into risky Investent Accounts, which provide the banks with the funds to engage in speculative bets.

Should the bets fail, the depositor loses. There would be no guarantees on these funds.

The fixed-term nature of these funds means they are no able to be used “to pay or settle transactions through the payments system, meaning that they are unable to use Investment Account balances as a form of money.”

The difference between the SMS in this regard and the current system is that loans do not create new deposits in the SMS:

… commercial bank lending in the Sovereign Money System does not increase the quantity of money in circulation; the act of making loans merely transfers pre-existing money from the bank’s Investment Pool to the borrower’s Transaction Account.

At first blush, a lot of people think that this means that bank lending becomes constrained and controlled by the central bank because the latter would determine the total pool of ‘money’ in the system.

But as we will see, the central bank would still be beholden to ‘fund’ the system through loans to the commercial banks should there be insufficient ‘money’ in the system at any point in time relative to the demand for loans from households, organisations, and firms.

The Money Creation Committee (MCC)

A crucial part of the SMS proposal is that:

The power to create money will be held by the CBI while parliament will decide how any new money is allocated. The power to create money is thereby separated from the power to allocate new money.

So you immediately see that the conservative mistrust of elected democratic government persists in this proposal.

The SMS proposal says that:

Concerns exist that if governments are allowed to create money directly, they will get carried away and create excessive amounts of money to pay for vote-winning projects.

Under Sovereign Money, however, the government is not allowed to create money directly. The decision to create money would be made by a money creation committee, independent of government, on the basis of what is appropriate for the economy as a whole.

I do not support frameworks where key economic decisions are handed to an essentially unaccountable body which then constrain the Parliament we elect to be our agents.

This would continue the voluntary system of constraints (albeit change the type) that conservatives place on governments to hinder their capacity to generate full employment.

I find it odd that we design systems that undermine our collective well-being and punish individuals severely (via unemployment and the resulting poverty) because we don’t believe our governments will act honestly or competently.

There needs to be much more work done at the grass roots level to ensure our political processes are improved. The process of candidate selection needs to be improved and local communities should resist any central imposition of preferred candidates to act on their behalf.

I would argue that political funding should be publicly provided and no lobby group funding accepted. Major electoral reforms are needed to to eliminate the influence of lobby groups, to reduce the power of media concentration etc.

Then we come to the Monetary Creation Committee.

The proposal says that:

Decisions on money creation will be taken by a committee that is independent of government and transparent in its decision-making, as is the current monetary policy committee.

So the central bank would increase the money supply in line with its inflation forecast and the target economic growth rate. So if they wanted to maintain inflation, say at 2 per cent per annum, and to support a 3 per cent real GDP growth rate, they would allow the money supply to expand at 5 per cent (which in theory would permit nominal GDP to grow at that rate).

I am told that complaining about the anti-democratic nature of this arrangement is moot given the current system has central bank boards determining monetary policy anyway.

However, the SMS extends that unaccountable technical expert syndrome further. The idea of independence is interesting in this regard.

The concept as used means it is not sensitive to the political process. But who would appoint the MCC? Further, like the current arrangements with central bank boards, fiscal advisory bodies (CBO in the US, OBR in the UK etc) the appointees are typically ideological warriors.

In the current system, there is no diversity of opinion or paradigm on these bodies. Straight-down the road neo-liberalism. Which means the decisions of the MCC will reflect the prevailing ideology of the day which is a different thing to promoting society well-being.

The fact that nations tolerate entrenched mass unemployment as a ruse to fight inflation, when superior inflation-fighting job creation strategies (for example, the Job Guarantee) are available indicates where the biases lie and who would bear the costs.

The MCC would likely, under current ruling ideology, promote a growth rate that was too low and adopt ‘cold turkey’ adjustment paths following the Friedmanesque “short sharp shock” approach.

It is also likely that cycles would intensify under this arrangement because if the economy was overheating somewhat (with inflation accelerating), the money supply would be restricted to reflect that.

It takes time to discipline an inflation cycle and real output changes much more quickly than the price dynamics.

What if the MCC made a mistake? The previous point would suggest that the MCC would be subjected to conservative biases in the current situation and restrict the money supply unnecessarily.

This is a different point to the usual criticism that the MCC would make errors as a result of ignorance (not enough information etc). The SMS proposal acknowledges that possibility but asserts that:

… it would also hard to believe that a committee tasked with creating the proper amount of money for the economy would consistently create money to similar excess as the commercial banks have done in the past.

Unaccountable organisations such as the IMF have made massive errors costing billions and causing millions to lose their jobs in the past.

Policy mistakes are part of living in an uncertain world but if fiscal policy (including money creation) is in the hands of the government then as part of the democratic process we are able to punish the decision-maker who errs, should we choose to do so.

Arrangements (such as the SMS proposal) which divorce decision-making from political responsibility and accountability do not allow us to exercise that choice.

Perhaps a rule whereby the members of the MCC had to pay a significant fine if the unemployment rate strayed from it true full employment level would concentrate minds and improve accountability!

But then I would apply that rule to government ministers as well and leave the decision-making power in their hands.

The possibility that the MCC will make errors also leads to another aspect of the SMS proposal.

The Report says:

The concern has been raised that removing the banks ability to create money for lending may cause a reduction in availability of loans compared with the present system and the reformed system would be too constrained.

This is highly likely unless there is an additional source of money available.

And, to be sure, in the SMS proposal there is the capacity for the central bank to make loans to the private banks – that is, provide funds to allow the banks to extend credit “to meet demand for loans from creditworthy borrowers and businesses”.

At this point you will appreciate that nothing much changes then.

Banks can still get funds from the central bank without the need to first try to get funds from the wholesale or retail markets to ensure they can continue to create loans.

The central bank remains responsible for fully funding the system just as now.

The alternative is that the credit market would become tight and banks would be competing among themselves for depositors with the consequence being that the interest rate would rise.

In that sense, the central bank would lose control of its monetary policy target. By setting the quantity (money supply) it would be forced to allow the ‘price’ (interest rate) to go to whatever the market determined.

If the MCC underfunded the economy and a credit squeeze occurred, then rates would skyrocket and presumably stifle economic activity (to whatever extent total spending is sensitive to interest rate changes).

The alternative is as is the case now – the central bank provides the funds to ensure the rate remains at its target levels and the demand for liquidity in the economy is satisfied.

All the smoke and mirrors about stopping banks creating money falls aside as soon as we understand that the central bank always has to fund the monetary system or else face the fact that recession and financial instability would follow.

We also see that the SMS proposal still allows the private banks to leverage off the net financial assets (‘money’) created by the State and profit accordingly. So all the moralising about preventing the private banks from determining the allocation of credit should be seen for what it is.

Further, while the SMS proposal says that such loans to the banks will not be able to be on-lent to financial or property companies, it is naive to think that an individual or firm who borrows the funds will not engage in speculative behaviour themselves which are not in the public interest. Just as now.

Fundamental reform is required

Drawing lessons from the Icelandic bank collapse and the GFC generally, tells me that more fundamental approaches to financial market reform are required and that the problem is not related to the credit-creation capacity of the banks.

1. Government treasury and central bank operations should be brought under the “one roof” and the sham of central bank independence abandoned. Please read my blog – The sham of central bank independence – for more discussion on this point.

This aligns the major arms of macroeconomic policy making with the democratic responsibility and accountability.

2. All voluntary constraints on net spending and the institutional machinery that has arisen to implement these constraints, which have lead to unsustainable outcomes with the costs of the dysfunction being borne mainly by the less advantaged groups in the society, should be abandoned.

That is, I would recognise the differences and advantages that a government in a fiat monetary system has over one operating in a convertible currency system (Gold Standard) and create behaviours and institutions that allowed the the government to exploit those advantages to advance public purpose and generate full employment and environmental sustainability.

Such borrowing is unnecessary to support the net spending (deficits) given that the national government is not revenue-constrained and does not advance public purpose.

This would mean that the net spending would manifest as cumulative excess reserve balances at the central bank.

I would maintain that excess liquidity in the system and keep short-term interest rates at zero or just about. All adjustments to aggregate demand are better made using fiscal policy.

I would abandon all tax incentives, which push speculative behaviour in property markets.

3. Central bank lending to its member banks (those who have reserve accounts with the central bank) should never be constrained and should be priced at whatever the current rate for lending to banks is. By rejecting the “money multiplier” view of the world, we learn that commercial bank lending is not reserve-constrained.

The trick is to change the way the banks operate not restrict their capacity to be banks.

4. The only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers.

Attention should always be focused on what is a reasonable credit risk. Banks should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets.

This would stop all third-party commission deals which might involve banks acting as ‘brokers’ and on-selling loans or other financial assets for profit.

It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate. Banks should go back to what they were.

5. Banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully.

6. Banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.

7. Banks should never be allowed to trade in credit default insurance. This is related to whom should price risk.

8. Banks should be restricted to the facilitation of loans and not engage in any other commercial activity.

9. Eliminate the vast majority of speculative trading in financial products by declaring them illegal. Almost all (around 97 per cent) of speculative activity in financial markets does nothing to advance public well-being. Financial market regulation should always be motivated by allowing activities that improve our collective lives and scrapping the rest.

By eliminating much of what we now call the FIRE industry, the life of the banker becomes much simpler and safer.

10. Make banks public institutions and make their non-profit mission to unambiguously pursue public benefit.

There are many other points that could be made but these suffice to show that the SMS is not a model for a better financial system. We could go into deeper discussions about what is money etc but I avoided that level of technicality because the proposal fails much earlier than that.

1. You claim the SMS report thinks “national government is financially constrained” because it claims the state “foregoes considerable income it would earn from creating new money”.

The fact that someone favors the state foregoing a chunk of income by letting the private sector reap the profits from doing something does not prove that person thinks the state cannot print money, i.e. that the state is “financially constrained”.

Indeed, PM specifically advocates having the state print and spend money in a recession, just like MMTers do. PM has made that point about fifty trillion times.

2. In similar vein, you make the bizarre claim that because SMS thinks the state has to guarantee deposits, that therefor SMS thinks the state is “financially constrained”. Nonsense: the fact that the state undertakes a particular task (guaranteeing deposits or whatever) has ABSOLUTELY NOTHING TO DO WITH whether the state can or can’t print and spend money at will.

3. You appear to miss important point that if the state guarantees deposits free of charge, that’s a SUBSIDY of banking. Subsidies as you presumably know, misallocate resources. They reduce GDP unless there’s a very good social reason for the subsidy as for example in the case of education for kids. Indeed, the word “subsidy” does not appear in either of your two articles on full reserve banking.

As distinct from countries where deposits are guaranteed at no cost to banks or depositors (e.g. the UK), there IS A CHARGE for deposit guarantees for small banks in the US: the FDIC does that. But even that’s a nonsense – for reasons I won’t go into right now.

Well I’m only a quarter of the way thru your article. It’s time for my coffee break. I’ll continue shortly.

‘All the smoke and mirrors about stopping banks creating money falls aside as soon as we understand that the central bank always has to fund the monetary system or else face the fact that recession and financial instability would follow.’

This is the recognition that pushed me away from Positive Money UK, as well as Neil Wilson’s blog post to which you refer. Thank you for so clearly expressing the point that I tried unsuccessfully to put in my comments on Part I.

Historically, there have been instances of banks who were not legally permitted to take deposits. They were simply unable to fund their lending through equity alone – the return wasn’t high enough. Here is how a bank analyst I know explained it to me: Equity investors typically require something like a 10% return to compensate them for the risk. If it’s totally equity financed and the interest rate on the customer loans is (in normal times) 5-6% then this isn’t a good trade. Instead, banks issue debt of one form or another (repo, unsecured bonds, covered bonds). They gear up their balance sheet until they reach a circa 10% return.

If equity is the only option for investment banks, the price of lending will go so high as to cause a recession, as you say, unless the central bank (as you quote the SMS document) provides them assistance with which ‘to meet demand for loans from creditworthy borrowers and businesses.’

And if a bank accepts this sort of assistance from the state, as you and Neil both point out, it ought to be expected in return to comply with strong regulations, keeping it to a very narrow role.

5. Banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced.

A lot of Ralph Musgraves comments rely on an assertion that bank will no longer need to be bailed out to support economic stability. I think the NZ experience around the financial crisis should highlight this is unlikely to be in any way true. In NZ the only real financial crisis was in the finance company sector. Finance companies lend money and in many ways act as banks, but were not before the crisis regulated or insured by our reserve bank (they appear to be a very close analogy for private banks). Never the less when many of these institutions got into trouble the NZ government passed legislation in a hurry so that they could access credit again. If it had not done so there is plenty of reason to believe that the economic downturn as a result of their collapse would have been more severe. This implies that even when the government is not formally on the hook to insure lending institutions its still on the hook to insure lending institutions due to their size (and the size of the hole left by their collapse). If the reserve bank had been regulating (and insuring) these institutions to begin with then a lot of the fraud (as subsequently prosecuted in the NZ courts) might have been avoided.

You claim, “A lot of Ralph Musgrave’s comments rely on an assertion that bank will no longer need to be bailed out to support economic stability.” You’re conflating two separate issues: first rescuing banks and second, economic stability.

I’m saying that where banks are funded just by equity, they cannot go insolvent. But I’m NOT SAYING that therefor complete “economic stability” is therefor guaranteed. Indeed, given a series of silly bank loans, bank shares would fall and there’d probably be a reluctance to buy bank shares for a while, so bank loans would decline. Hence aggregate demand would decline.

In that situation there’d certainly be a need for the state to implement stimulus. The net result would be less loan-based activity and more non-loan based activity. And where banks have made silly loans that’s a good indication the bank industry has got over confident and needs to contract. So I make no apologies for not being in favor of “supporting economic stability” by rescuing incompetent banks.

“I’m saying that where banks are funded just by equity, they cannot go insolvent.”

The PM proposals don’t prevent any business from issuing bonds, clearly these companies were insolvent simply due to a mismatch of their assets and liabilities. A very similar mismatch can clearly occur under a system of lending exclusively based on time-deposits. There is no reason that the lending arm of a bank or other financial institution form would only be funded by equity under those proposals. The fact that a purely deposit providing institution, with 100% reserves (e.g one which is only funded by equity) cannot go insolvent is not in any way at issue here.

Clearly if a 100% reserve bank is engaging in lending in some fashion and becomes insolvent, then its still able to cause a financial collapse, and where that is big enough there is likely to be an implicit if not explicit insurance policy.

“In that situation there’d certainly be a need for the state to implement stimulus.”

Which they did in NZ, by bailing out the finance company sector, I see no reason that anything different is likely to happen under an otherwise similar system.

To me the biggest gaping hole in the Positive Money proposal is that unless the country implementing it (Iceland) imposes very tough capital controls similar to what was in the Soviet Bloc in the 1950s people will be able to access “normal” credit extended by “normal” banks overseas what would lead to instability of the exchange rate, fuel derivatives trading (due to hedging) and lead to ultimate loss of control over credit creation.

Another issue closely related to already mentioned weakness (Central Bank can either control the quantity of credit or the interest rate, not both) is that “revolving credit” which helps businesses execute their daily operations may no longer be available on demand because the quantity of available savings might not match the current needs of the borrowers / investors. There are 2 types of loans – short term which provide funds lubricating normal business activity and long-term (either financing investment or consumption, sometimes misused for leveraged speculation). Since the quantity of loans is supposed to be restricted, long-term loans can crowd out revolving credit and kill the economic activity. I cannot imagine functioning of the modern financial system with restrictions coming straight from the 13th century. The country which puts the burden of pre-saving and dealing with unstable interest rate on its businesses will simply lose competition with other countries. If the Central Bank stops targeting quantity of credit then we are back to the current regime with some lipstick on a pig (what was already mentioned in the main blog).

Yet another weakness already mentioned in Neil’s blog is the maturity transformation fallacy. Unless each loan is backed by a deposit with the same or longer maturity a commercial bank can become insolvent or the Central Bank has to intervene. More lipstick on the same pig – nothing has changed.

Unlike Neil who finds traces of feudalism in the ideas mentioned above and thinks about Lords capriciously dispensing credit (or not) I can smell rotten Stalinist central planning thinking behind the whole concept of pre-allocating and rationing credit for the productive economy.

You say, “There is no reason that the lending arm of a bank or other financial institution form would only be funded by equity under those proposals.” Actually I think there ARE GOOD arguments for that “equity only” option. Certainly it’s the option favoured by Milton Friedmand and Laurence Kotlikoff, for what that’s worth. The arguments are briefly thus.

Having a lending institution funded by deposits involves a blatant self–contradiction, as follows. Institutions which accept deposits claim those deposits are totally safe, but it’s quite clear they aren’t if relevant monies are loaned on or invested: there is no such thing as a totally safe set of loans or investments. Or as Prof Adam Levitin put in in the first sentence of the abstract of a recent paper, “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and relending of deposits.” See:

That problem can be solved if just ultra safe institutions or bank subsidiaries etc accept deposits, while lenders are barred from accepting deposits. But that in turn raises the obvious question as to whether that raises the cost of funding lenders. Well the answer is: “not if the Modigliani Miller theory is right”. That theory states (very briefly) that the risks and hence funding costs of a bank are determined PURELY BY the nature of its loans: i.e whether they’re risky NINJA loans or more conservative loans. Changing capital ratios does not of itself change the nature of those loans, ergo changing capital ratios has no effect on the cost of funding lenders.

You start by assuming that just one country implements PM ideas. One answer to that (not a totally satisfactory answer I know) is that there are organisations like PM all over the world. So ideally several countries would implement sovereign money at the same time.

Second I have no intention of giving up on an idea just because some people might abuse the idea. No doubt when the UK’s National Health Service was first proposed some people argued that free riders from abroad would come and get treatment they weren’t entitled to. That wouldn’t have stopped me backing the NHS.

Next, in your second paragraph you claim that a PM system involves severe restrictions on credit (that’s credit in the “availability of money” sense of the word, rather than availability of trade credit). My answer to that is that exactly the same restrictions apply under the existing system, although I realise lots of people think that because a private bank can make instant loans to any viable borrower that such restrictions don’t exist.

The reality is actually that, assuming the economy is at capacity, it just ain’t possible for loads more money to be created and loaned out: demand and thus inflation would become excessive, thus the central bank / state would raise interest rates and cut back on the lending (or implement some other deflationary measure). Alternatively if the economy is NOT AT capacity, then those additional loans are possible, but by the same token, in that scenario under a PM system, the state would be creating and spending extra money.

Please do. This is the first time I’ve seen a Positive Money proposal analyzed in this kind of detail, but I’ve always recognized very early on in PM discussions that the supporters did not have a good handle of what money is, and that’s allowed me to dismiss them without doing that detailed analysis. My guess is that efforts to spread MMT would benefit from a focus on what money is, and how non-MMT proposals can be recognized as suffering from a lack of understanding this.

I think the greatest logical hole in the ‘banks shouldn’t be able create money’ argument is indicated by Minsky’s famous statement that anybody can create money; the problem is to get it accepted.

Anybody can create money by convincing somebody to hold her IOU (the state does it by accepting its own IOUs for tax payments). So you can’t stop banks or anyone else creating money – what are you going to do, ban double-entry bookkeeping? The best you could do is try to stop bank IOUs from being accepted on their own. You could try to make them settle all payments with delivery of reserves (central bank IOUs) within – what – an hour? a day? two weeks?

But all you have to do to convince people to hold your IOUs for a longer delivery period is look solvent. Banks look solvent for many reasons – they are big enough to absorb risk, they have the resources to do thorough underwriting, and, of course, they have access to the lender of last resort and deposit insurance. Easy access to the payments system helps, but I don’t see how it’s essential. Yes, this gives banks the power to perpetrate fraud, overrate assets, and appear more solvent than they actually are. My banker friends may not like me saying so, but it’s obvious that almost all banks stay competitive under the current regulatory scheme by doing a bit of both. Thus the regulatory scheme should change to make them to do less of the fraud and more of the sensible risk management and proper underwriting. This post contains many proposals to that effect.

But the naïve idea that we can solve the problem by stopping banks from creating money is bogus. Anyone can create money, and if you get big enough to absorb risk you can easily convince people to hold your money. We can’t deprive banks of their special status of being able to issue IOUs that are generally accepted in payment. All we can do is make them deserve that status.

It gets easier once you realise we don’t actually use ‘money’ to buy things. We buy things or we prepare to buy things and run up credit. Then we generally swap that credit for some other credit that the debt holder finds acceptable, which shrinks our balance sheet back down so we can start again.

If you live in a parochial town like I do, where reputation matters, then you can actually swap that credit around. I can give the credit the scrap metal merchant gave me to my plumber because the plumber and the scrapper are best buddies and they know the credit is good. After a while though it gets a bit messy doing it like that and you invent a middleman to handle all the swapping of credit around. They can even discount the credit of those who are known to be slightly less reliable than others. You put such a place in an imposing building in the middle of the town and call it a ‘bank’.

The whole of the pm proposal is based upon the wrong view of the world – the so called ‘currency view’. It was defeated as foolish when it was originally raised and it will be defeated again. Because it makes no sense whatsoever to anybody who understands the accounting and simply doesn’t work to control banks.

The people putting it forward are primarily political activists with a good line in marketing and PR. They don’t know much about banking and even less about how to control a system. It’s a pity they have to waste their time with something that simply doesn’t work, when the MMT proposals to narrow banking are very clear and would work to control the banks properly – particularly removing collateral which would help end the asset price spirals we’re seeing. Banks are about providing liquidity on future asset income streams, not liquidity on existing assets.

As I said before the pm people are useful fools. Bankers love useful fools. It’s a distraction that prevents the banks being contained properly.

@Neil
“The people putting it forward are primarily political activists with a good line in marketing and PR. They don’t know much about banking and even less about how to control a system.”

Therein lies the problem.
Enough people pooled into an activist mindset albeit a superficially well meaning paradigm which is wrong at some level of abstraction. The emotional investment in the idea is bundled up such that they cannot understand nor want to understand something which requires nothing more than picking up books about Minsky, Graziani or Knapp.
If done a correct solution could be found; Revise the mechanics keep the same broadly aspired goals.

Agree with the main two points
i)Limiting government spending, and only allowing the Money Creation Council because Politicians can’t be “trusted” is terrible idea.

ii)Having a Central Bank lend private Banks Money so that they can lend to productive businesses so that they can impose an arbitrage mark-up for “efficiently” allocating capital strikes me as another type of subsidy for this cosseted sector.

Having said that, the Greens intend to have monetary reform, but alongside a local public bank in every community on the high street and online to provide people with access to cheap credit, with no profit margin necessarily imposed on the cost of credit.The BoE (Actually they intend to use the nationalised RBS) in every High street, providing secure bank accounts and low cost loans for productive investment in the private sector. The Central Bank will simply supply funds at no cost to local banks to provide appropriately deemed credit worthy borrowers with loans, a whatever cost deemed socially and economically productive, in my mind negligible, if not zero.

@axdouglas “I think the greatest logical hole in the ‘banks shouldn’t be able create money’ argument is indicated by Minsky’s famous statement that anybody can create money; the problem is to get it accepted.”

I always thought this line of reasoning was disingenuous of Minsky because Banks don’t just create/lend IOU’s but do so in the unit of account / national currency of the country. That’s altogether very different from me writing up an IOU lending it to you; which you can then trade with a third party…..and then expecting you to pay me back with interest. Seems reasonable to ask if banks can do it, why can’t You or I.

@Neil you make it sound far fairer and equitable and accessible that it actually is, the costs of credit is restrictive and the selective rationing of credit can undermine development and demand in local communities.

However: “particularly removing collateral which would help end the asset price spirals we’re seeing. Banks are about providing liquidity on future asset income streams, not liquidity on existing assets.”
Your right this policy would be very radical (a good thing) and make borrowing far fairer and systematically stabilising. The emphasis needs to be on having a Public option in Banking which can support the public purpose. Alongside the strict controls such as not being able to sell of loan assets off a balance sheet; and the rest. The key to shifting tax incentives away from property of course would be the introduction of land value tax.

Still agnostic on monetary reform providing it was done without a Dictatorial MCC(Government should be able to spend whatever amount they require). But with a public local bank which provided Loans at whatever the central bank was, i.e. undercutting private banks benefiting from imposing a profit margin on interest rates (which would simply be a form of monopoly/regulatory capture).
The Public local bank would pursue the public purpose. And operate with all those same restrictions.

@Bill point 9 is a minefield of difficulties I would have thought: a farmer using weather/grain futures to hedge food production costs, is that a disservice to public well-being? How can we differentiate between speculators and genuine market participants

Jake, you say
“with no profit margin necessarily imposed on the cost of credit.”
How will they make profits? What will incentivise good underwriting.
Of course the current banking system does not do this either.
MMT bank narrowing proposals seem sensible.

“The key to shifting tax incentives away from property of course would be the introduction of land value tax.”
Strongly agree. But land speculation is not the only thing that is wrong. We should encourage banks to invest in the capital development of our economy.

Re your claim that “anyone can create money”, can Mr Axdouglas create money in the form of IOUs written on scraps of paper and get them accepted in local supermarkets? Obviously not: indeed you yourself point out (quite rightly) in your last paragraph that you need to be “big” before you can “convince people to hold your money”.

But the mere fact of being “big” means you can’t escape the notice of the authorities! And by “big” I mean all the regular banks and the bigger shadow banks. And the authorities audit banks’ books (a job they do ANYWAY). Plus it should be obvious from a quick look at a bank’s balance sheet whether it is creating money or not. E.g. in a PM system where lending banks are funded just by equity, there should be JUST EQUITY on the liability side of the balance sheet, not money.

Neil,

Your story about a village where debts are shifted around between yourself, the local plumber and the local scrap merchant with those transferable debts performing the function of money is straight out the realms of fantasy. Obviously that’s possible IN THEORY, and doubtless that took place in the Middle Ages.

The reality nowadays is that for 95% of transactions businesses want cash: conventional money – £20 notes etc. That is VASTLY more convenient that transferring debts around between plumbers, scrap metal merchants etc.

Of course if the state and/or private banks supplied the country with a GROSSLY INADEQUATE amount of money then DIY forms of money would arise. But under a PM system, the state aims to print and spend whatever amount of money is needed to keep the economy at capacity or full employment. Indeed, MMTers advocate exactly the same, except that MMTers let private banks print money as well.

“Re your claim that “anyone can create money”, can Mr Axdouglas create money in the form of IOUs written on scraps of paper and get them accepted in local supermarkets? Obviously not: indeed you yourself point out (quite rightly) in your last paragraph that you need to be “big” before you can “convince people to hold your money”.
But the mere fact of being “big” means you can’t escape the notice of the authorities! And by “big” I mean all the regular banks and the bigger shadow banks. ”
What about e.g bitcoin? And local currencies have been created before.

So far Bitcoin and local currencies are just a minor and harmless bit of fun. If I were running a PM system I wouldn’t bother banning local currencies. Indeed most PM supporters I know favor local currencies.

I don’t see Bitcoin being a serious competitor for the state’s money, but if it did become that, I think most people would want it banned. I.e. I suggest most people want to see the country’s money supply being administered by the state – by their government. Russia and several other countries have banned it or will do shortly.

@Bob
That’s a public bank,a high street branch of the BoE.It doesn’t need to make a profit.Local branches will want to do a good job of maintain a healthy portfolio of well performing loans.I expect a decent salary will suffice in incentivising quality risk assessment.

@bob Well a public bank could be ordered to finance economic development,by providing cheap loans.
That’s how the east Asian tigers built up their private sector,by providing cheap loans to develop certain sectors.Many becoming world competitors.
They would rely on civil servant to monitor the businesses and any failure would result is a swift removal of credit lines;no issue of supporting loss making firm over the mid and long term.

State banking seems the obvious answer to me.
I do not mean nationalize existing private banks.
They can carry on but without state support.if you want your
deposit guaranteed ,bank in a state bank.If you want to take
out a loan as a householder or firm see if you meet your states
banks public purpose criteria if not try a private bank.
Of course your state bank can run a counter cyclical strategy both
on criteria and interest charged on deposits and loans.With higher
levels of private sector deficits it could offer pension bonds if their
are inflationary pressures.
Private banks do not get bailed out or customers wanting to protect
their deposits.(transaction accounts).The reserve ratios for the private
banks and the state bank are irrelevant.
An account for every citizen over 18 complete with a citizens wage direct debit.

You say “allowing the Money Creation Council because Politicians can’t be “trusted” is terrible idea.” Bill Mitchell expressed a similar sentiment. However there just one teensy problem there:

We already put stimulus decisions into the hands of a non-democratic committee of economists!!!!! In the UK, it’s called the Bank of England Monetary Policy Committee. And we do that because we don’t want to give politicians direct access to the printing press. Other countries have similar committees.

To expand on that, the TOTAL AMOUNT of stimulus is decided by the latter horrendously undemocratic committee, while strictly POLITICAL decisions like what proportion of GDP is allocated to the public sector remain (quite rightly) with politicians and the electorate. And that wouldn’t change in the PM system, as PM have explained till their blue in the face.

I’ve tried to explain that point to Neil Wilson a dozen times, but he just never gets it. Please, please, please let me know if YOU understand it. It seems a very simple point to me. If you don’t understand it, I’ll explain using more words.

“And we do that because we don’t want to give politicians direct access to the printing press. ”
? This view just strikes me as odd.
Of course politicians have access, all government spending is by crediting bank accounts.
And why would “giving politicians access to the printing press” be bad, Ralph, compared to now? Even if they spent it on crap there would be stimulus effects. At least we can vote out politicians if they screw up.

“We already put stimulus decisions into the hands of a non-democratic committee of economists!!!!! In the UK, it’s called the Bank of England Monetary Policy Committee. ”
Indeed. But I don’t see how this advances your argument. You could argue for both interest rates and fiscal policy, only one or neither being decided by a committee.
Personally I would prefer neither. We get it Ralph, we simply disagree with you. I don’t see how putting something in the hands of an undemocratic committee is better than politicians, despite all their faults. Look at the damage the ECB have caused since having (effective) control of fiscal policy. Plus, it won’t stop at that, how about giving the committee powers over structural reforms and the like. Even if it was a good idea, I don’t see the pressing need for it, we have bigger issues. Could you give some examples as to the advantages of the committee approach. I think most MMTers want “control of the printing press” held by the public.

“TOTAL AMOUNT of stimulus is decided by the latter horrendously undemocratic committee, while strictly POLITICAL decisions like what proportion of GDP is allocated to the public sector remain (quite rightly) with politicians and the electorate.”
What if the public strongly disagree with the committee of economist’s decisions on the amount of stimulus?

For example many economists believe in the NAIRU approach that underestimates stimulus. Another example is the committee persuing wrong approach to kick politicians out of office see e.g. Jimmy Carter/Paul the inflation a buster which lead to Ronnie’s election in 1980.
Far better to use auto stabilisers than a committee of experts.

Also, surely with low stimulus the central bank can make some projects unviable and effect composition of spending?
If you hate politicians having access to the “printing press” might as well continue with current neoliberal system.

@Ralph Musgrave,
Sorry to break up the thread of the discussion, it took me a while to notice your latest reply.

“Having a lending institution funded by deposits involves a blatant self–contradiction, as follows. Institutions which accept deposits claim those deposits are totally safe, but it’s quite clear they aren’t if relevant monies are loaned on or invested: there is no such thing as a totally safe set of loans or investments.”

Its simply not the case that deposits and deposit taking institutions are the crux of the issue here. As I highlighted in NZ it was the finance company sector which went wrong (not the banking sector). Investors in these schemes could not be under any miss apprehension that they were depositing money with the finance companies (which were offering high interest), most of their investment would have been of bond form and quite similar to a scheme of time deposits under a more strict PM proposal.

“That problem can be solved if just ultra safe institutions or bank subsidiaries etc accept deposits, while lenders are barred from accepting deposits.”

Not in NZ, the finance companies were all running investment schemes, not deposit taking schemes (though many people seem to have been under a massive miss-apprehension as to how safe their investments were). This in no way prevented the government from deciding to (or in my opinion needing to) bail them out, due to the size of the hole in the economy which would be left by their collapse.

Contradicted by this one (from the previous paragraph),
“That theory states (very briefly) that the risks and hence funding costs of a bank are determined PURELY BY the nature of its loans: i.e whether they’re risky NINJA loans or more conservative loans.”

To me, it seems that the Sovereign Money proposal is at its essence another run of the mill diversionary tactic that seeks to assign blame anywhere other than where it duly belongs. A public relation exercise that champions form over function.

For some inexplicable reason the actions of individuals who made themselves fabulously wealthy through fraud, deceit and other illegal acts while controlling banks ( a legal construct ) has somehow morphed into a fault of the monetary system?

I see no evidence, nor have I read any argument that convinces me that the Sovereign Money proposalreduces or eliminates bank fraud, asset bubbles or any other undesirable outcome of the banking sector.

At the same time, I see the proposal as eerily similar to the TPP / TTIP so-called “free trade” deals. Both of which are designed to impart more power into the hands of the unaccountable ruling elite, circumventing democracy and the will of the people.

The suggestion of giving the power over a nations sovereign monetary system to an unelected group of lackeys representing the faceless 0.01% should make everyone sick to their stomachs.

Prof. Mitchell’s criticisms concern Iceland’s proposed Sovereign Money System, which is similar to the ideas of the Positive Money group.
Other serious criticisms can be made regarding some of other proposals which include full reserve banking,
e.g. Friedman’s espousal of full reserve banking as means to control the money supply.
and Kotlikoff’s proposal for “limited purpose banking” with a “Federal Financial Authority” which would “verify, appraise, rate, take custody of, and disclose, in real time, all securities” held by financial institutions.

However, Prof. Mitchell’s criticisms DO NOT APPLY to earlier much simpler proposals for full reserve banking, in particular the proposals of the Chicago Plan & Irving Fisher in 1936. Let us consider just 3 of Prof. Mitchell’s valid concerns with the SMS/Positive money proposals.

(a) A New Monetary Committee.
Simpler proposals for full reserve banking do not include any unnecessary undemocratic features like Positive Money’s “Money Creation Committee” or Kolotikoff’s “Federal Financial Authority”.

(b) “interest rates would rise beyond the control of the central bank”…”the central bank would lose control of its monetary policy target”
This is plainly incorrect. With full-reserve banking the state could still control interest rates by buying and selling bonds, as under present arrangements. Transactions/deposit taking banks would no longer participate in these open market operations because their assets would have to be reserves at the Central Bank (or maybe other very safe liquid assets like short-term Treasury Bills).
However, there would still be a huge market for government and commercial bonds which would continue to be held by mutual funds, pension funds, investment banks, insurance companies and private individuals, and also foreign banks, companies and sovereign funds.

(c) “reduction in availability of loans” …. “recession and financial instability would follow”…the central bank always has to fund the monetary system”
Prof. Mitchell is right in noting that Positive Money appear to want to control the money supply, like Friedman. However, this is not an essential feature of full reserve banking. It would be equally possible with simple full reserve banking to operate monetary policy and the economy in line with MMT, i.e. with a target interest rate rather than a target money supply.
Any scarcity of loans would be reflected in interest rates. As noted in (b) above, the government would retain full control over interest rates. In achieving its interest rate target, the government simultaneously provides appropriate “funding of the monetary system”. The resultant “quantity of money” is a consequence, not a policy target.
There is a highly competitive international capital market with many innovative enterprising investment banks. So with simple full reserve banking firms would soon find alternative sources for the small proportion of investment funds which is currently provided by deposit taking banks.

the basis of banking cronyism is the states deposit guarentee for funds
in private firms.
If banking is that important to public well being and dysfunctional enough to cause
major economic crises ( and general parasitic behavior) the state should not support it.
I do not support traditional socialist nationalization or public ownership of production
in general.But just as the state provides education services or health services here in the uk
I believe it should provide bank services and withdraw its support from the parasites.
This should apply to other dysfunctional sectors the private housing rental market springs
to mind.

Again: bringing in the word ‘equity’ makes no difference to the mechanics of the system. Suppose the only currency officially accepted in payments consists of Bradbury pounds issued exclusively by the State, and we have your banking system. I buy 100 shares in a bank, paying with my own Bradbury pounds. The bank then lends out the Bradbury pounds, which circulate.

Now I decide I want to buy something. Rather than selling my bank shares for Bradbury pounds, I just hand over the shares themselves to the seller. There’s no reason she won’t accept them if she thinks the bank is solvent and the shares won’t collapse – never mind what’s officially accepted in payment. So those shares will circulate around while my original Bradbury pounds are still circulating around. The bank has ‘created money’ in precisely the same sense as it does under the current system. When loans are repaid to bank, it uses the Bradbury pounds thus received to retire the shares, which can no longer circulate. Money is ‘destroyed’ in precisely the same sense as it is under the current system.

Also: if a bank expects people to purchase a given volume of equity soon, it can lend out the proceeds of those sales before they actually go through; it just has to borrow the Bradbury pounds from another bank. If it the timing gets screwed up (which of course, given the complexity of the system, it often will), the central bank will have to create and lend out however many Bradbury pounds it takes to keep the whole system from seizing up. This, also, is just like the current system.

Good point: at least a vastly more intelligent point than the points made by Neil Wilson and some other commentators above. The answer is thus.

ABSOLUTELY ANYTHING can be regarded as serving as money in the sense that it can be sold for money: cars, houses, antique furniture and, yes, the shares in your hypothetical bank. However that does not make cars, houses and shares a form of money as per dictionary definition of the word “money”. Dictionaries define money as something like: “anything widely accepted in payment for goods and services or settlement of a debt”.

But in saying that, I’m not suggesting there is a totally clear line between money and non money. Martin Wolf, chief economics commentator that the Financial Times, recently pointed out that government debt which pays a very low rate of interest more or less equals money. And MMTers have long pointed out that government debt can be regarded as base money which is lodged in a deposit or term account. Wolf and MMTers are correct there.

Very interesting discussion.
It’s a bit off-topic, but i have been wondering – what is the situation with state government ‘budgets’ in Australia? As Victoria has just announced its’ budget, with investment in education and manufacturing, and it is not a currency-issuing national government, what is the situation with deficit/surplus spending?
I am new to MMT, so if anyone can point me in the direction of relevant info that would be great.
Thanks

You seem to be the first person in this discussion who is actually acquainted with relevant literature. Congratulations.

Re your “a” point, PM’s proposed Money Creation Committee is not one iota more “undemocratic” than existing central bank committees which decide on stimulus (interest rates, QE, etc etc). In both cases the committee decides on the TOTAL AMOUNT OF stimulus, but very definitely DO NOT decide on obviously political questions, like what proportion of GDP is allocated to public spending.

Re your point “b”, if the state under a PM system is going to control demand JUST BY ALTERING the amount of new base money created and spent, which is what PM, Prof Richard Werner and the New Economics Foundation advocate in their submission to Vickers, then ipso facto the state loses control of interest rates: or put it another way, it doesn’t even try to control interest rates.

However, I accept your point that the state COULD ADJUST interest rates in a PM system if it wanted to. Personally I think interest rate adjustments are farce, so I favor the above PM / Vickers submission system.

But look, I don’t want to argue over the definitions of words (see my blog post on Economics and Semantics). Define ‘money’ however you like; my point is that it’s hard to see any significant operational difference between your system and the current one.

To push the point further: suppose Bank A is expecting a big windfall of equity sales, worth £1m. It starts making loans in anticipation, borrowing the required Bradbury pounds from Bank B. Then the sales don’t go through for some reason. Now Bank B is short £1m of Bradbury pounds; it can’t make payments or loans. To preserve the payments system alone, the central bank will have to issue new Bradbury pounds and lend them to Bank B. Thus the banks – willfully or otherwise – have in effect conspired to force the creation of new Bradbury pounds by the central bank. Again, this is just like under the current system. So even if only Bradbury pounds count as money, the banks still have the power to ‘create money’, again in the same sense as it is true under the current system, even if we only define reserves as ‘money’.

Re the fact that Sovereign money is not a good counter to bank fraud or asset bubbles, the advocates of SM have never claimed that SM is a perfect solution to all problems in the bank industry. As a supporter of SM, I see the main advantage of it as being the prevention of bank failures, and subsequent credit crunches, years of excess unemployment, etc.

As to fraud, and to take a popular fraud namely failing to check up on borrowers’ assets and incomes (NINJA mortgages), that sort of sloppiness can happen under ANY system.

As to asset bubbles, SM would ameliorate bubbles A BIT. If the state loses control of interest rates, or makes no attempt to control them, which is what happens under SM, then interest rates will vary with supply and demand. And that’s no bad thing: it means that if there’s a surge in house buying, then interest rates will rise, which will at least to some extent choke off that house buying.

“I’ve tried to explain that point to Neil Wilson a dozen times, but he just never gets it. ”

I don’t get it because it is a different point and incorrect – certainly in the UK. You keep repeating the same thing like a mad thing.

In the UK the MPC committee chooses a rate *but the Treasury accepts that and allows it*. There is nothing in law that allows the MPC committee to set the rate *over the heads of the Treasury*. None. The Treasury has reserve powers to enforce its will if it chooses to.

There is no suggestion that the MPC can counteract government. It cannot. It is there entirely as a little game to fool people of small brains. It’s as independent as an eight year old.

In addition setting the rate and allowing the quantity to float is a totally different kettle of fish to trying to decide quantity. The base rate only affects things indirectly and imprecisely. The actual rates and quantities are set by the banks in negotiation with their customers and the amount of money actually injected in the economy is set by the government based upon how many Gilts it decides to issue.

The MPC and the OBR and lots of other quangos (like the one running the NHS) are examples of creeping autocracy and a systematic ideological attack on the idea of democracy itself. Those who control the purse strings *must* be elected by the people or you end up back in Feudal times ruled by Kings and Barons.

But then I hardly expect somebody who supports extreme right wing policies to understand how important universal suffrage and direct accountability is to an equal society.

That’s fine, but you should come out and say that you are against liberal democracy and for rule by the self appointed Lords of Expertise. I’ve seen quite a few economists be relatively honest and admit they dislike democracy and think things would be better with a benevolent dictatorship in place. Obviously with members of their class as the dictators.

“I see the main advantage of it as being the prevention of bank failures,”

Except that it doesn’t prevent bank failures. Never has and never will. Most business failures are cash-flow failures as any insolvency practitioner will tell you and banks will fail due to cash-flow issues regardless of how you setup the balance sheet.

The central bank and the regulators of the deposit protection funds can handle deposit flight very easily indeed by conversion to state funds on demand rather than ahead of schedule – as I’ve detailed in my piece above.

If you split a bank’s balance sheet into two as I have done and have a lending department and a deposit holding department you can see the effect more easily. The two systems are identical from an functional accounting point of view. You can make a current bank’s balance sheet a ‘currency view’ balance sheet simply by changing the accounting policy, splitting into departments and requiring the contigent insurance asset to be made explicit.

You can’t improve the banking control systems just by accounting jiggery poker and pricing changes. You have to alter what banks are allowed to do.

I hate to break this to you so read this very slowly and repeat if required.

Purchasing power is centralized so we do not live in a real democracy.

We have this fake ballot box democracy used to get people to participate in a lie.

Economics and therefore much of human existence. has become pointlessly complex as all power is centralized and then subsequently allocated again ( socialism takes many forms )
In a social credit system purchasing power is given as a basic right to the commons – any will to increase complexity comes from the bottom up.
This is a functional democracy rather then a fake one with all the trappings,

The euro is refreshing in one respect.
It reveals the workings of the system in much higher contrast.
The UK still uses effective albeit flagging propaganda on occasion.

Under full reserve, if your bank B makes unwise loans (say the value of those loans drops to half of book value) all that happens is the shares in that bank drop to about half their intial value.

(Incidentally I’m assuming the relatively simple scenario where banks / lending entities are funded just by equity, rather than PM’s system where they’re funded part by equity and part by long term deposits).

Re your claim that the central bank has to dish out more base money to “preserve the payments system” and lend that money to bank B, why so? As you rightly say, bank B will have a hard job making further loans, but who cares? It’s proved itself incompetent, thus it won’t be able sell further shares. It’ll be reduced to funding further loans out of money paid back by existing borrowers. It might very easily get taken over.

Re your claim that bank B won’t be able to “make payments”, I assume you’re referring to paying sundry administraton costs: staff salaries, rent of office space, etc. My answer that is that those costs are very small compared to the total assets and liabilities of banks, thus realistically, that’s not a problem. It’s the decline in value of assets which is the real problem (think Irish and Spanish property).

However, I agree (as I said in a comment yesterday or the day before) that IN THEORY it’s still possible for a bank to go insolvent under full reserve. But you’re talking about a level of incompetence which has just never happened. I.e. it’s common (particularly with small banks in the US) for bank assets to fall to 90 or 80% of book value. But falling to nothing at all is unheard of.

Re PM’s system, bank insolvency is more likely. PM admit that bank insolvency is possible under their system. That’s why I prefer the 100% equity model. However, PM would doubtless argue that insolvency is so difficult to “achieve” under their system that, if a bank did go under, it would almost certainly be just ONE BANK, not the entire system. So there’s no SYSTEMIC risk there.

No, I mean settling payments with other banks. Suppose somebody with an account at Bank B has paid with a debit card to a shop that banks with Bank C. Bank B was going to deliver the Bradburies over to Bank C tomorrow, thinking it was going to get its own Bradburies back from Bank A when Bank A sold the equity. Bank C was also planning to clear a few outstanding payments with the Bradburies it was expecting to get from Bank B. Etc. Payments are never instantaneous. So the failure of Bank A to sell the equity as expected sends a shock through the whole payments system, unless the lender of last resort steps in. Just like under the current system, with reserves instead of Bradburies.

Payments with debit cards to shops would be done with transaction accounts (to use PM parlance), or via the “safe half of the bank industry” to use others’ parlance.

All that banks or bank subsidiaries in that half do is to shuffle money or “Bradburies” between different people and firms when instructed to do so by customers. A “safe bank” cannot run out of Bradburies. Bradburies leaving one bank must arrive in another.

To be more accurate a bank COULD RUN OUT of Bradburies, but then it’s liabilities would be zero. E.g. if a safe bank subsidiary starts up and I deposit £X. Next day I withdraw the £X or pay it to my local garage, then the bank subsidiary’s assets are zero and its liabilities are zero.

Run a parallel system of credit. A quantative set of tokens/credit to facilitate exchange, accepted as a means of final settlement of a transaction (could be used to pay tax). As a state level this could in practical terms give you a means to pay for land rates or any state owned/run service.

@Ralph as I understand it Under the current system the Parliament/treasury determines fiscal policy-taxes and spending. Whereas the Bank of England and the Monetary policy committee determines interest rate and policy rate on an faux Independent basis from the treasury(since 98).The interest rate affects the cost of reserves on the interbank market, which in turn affects the cost structure of credit when banks lend to the public, as they are price constrained.

“the TOTAL AMOUNT of stimulus is decided by the latter horrendously undemocratic committee, while strictly POLITICAL decisions like what proportion of GDP is allocated to the public sector remain (quite rightly) with politicians and the electorate.”

I don’t follow that at all, how is total stimulus decided by the MPC?What Government deficit spending?
Interest rates do a bad job of stimulating bank lending anyway

Regardless as BoB pointed out, two wrongs don’t make a right. It was all managed by the treasury until very recently, might as well return to those state of affairs.

“if a bank did go under, it would almost certainly be just ONE BANK, not the entire system. So there’s no SYSTEMIC risk there.”
A e.g. housing bubble could happen. Plus, you don’t need full reserve for this.

So this is again the idea of all transactions being instantaneously settled. It’s not practical. This is an empirical claim that I can’t prove, but just look at the current payments system. It wouldn’t work without banks running billions worth of intraday and overnight overdrafts at the central bank. It’s a nice thought that all payments could be settled at the point of sale with a fixed volume of CB liabilities (or electronic Bradburies, or whatever). But it’s a fantasy.

Ralph PM does not prevent systemic risk. Your assumption is that the bank has only made loans. But in banking loans aren’t what banks do. Investing is what banks do. Sometimes those investments come in the form of loans, other times it comes in the purchase of other financial assets: Mortgage Backed Securities, Stocks, even equity of other banks. So long as you are not regulating what banks can acquire as assets you most certainly still have systemic risk. The failure of Bank A can always translate into the failure of Bank B and Bank C if Bank’s B & C are somehow directly (as in equity holders of Bank A) or indirectly (holders of crappy securities created by Bank A) involved in Bank A’s insolvency. Heck Bank A could even be perfectly solvent and be unloading enough garbage onto Banks B & C to survive while Bank B and Bank C alone go insolvent.

You ask, “how is total stimulus decided by the MPC?” (I assume you mean the Money Creation Committee (MCC)). The answer is exactly the same way as central bank committees currently decide on interest rate changes, QE etc. I.e. they look at all the available evidence on inflation, unemployment and so on and then have a vote on how much stimulus is suitable.

Under full reserve PM style, stimulus takes the form of creating new base money and spending it (and/or cutting taxes). That form of stimulus is what most MMTers favour, far as I can see. Plus it comes to the same thing as what we’ve actually done over the last three years or so: implemented fiscal stimulus and followed that by QE.

The committee decides the total amount of new money, while the question as to whether is used to increase public spending or cut taxes is up to parliament / politicians. Obviously $X of new money does not have the same stimulatory effect when used to increase public spending as compared to cutting taxes, so the committee would need to give politicians a range of options to work with in that connection.

Note that “creating new base money and spending it (and/or cutting taxes)” has both fiscal and monetary effects.

Re your idea that the whole thing is done by the Treasury, my objection to that and indeed most people’s objection is that gives politicians direct access to the printing press. It’s precisely to avoid that that central banks are made independent or at least nominally independent.

An alternative is to hand decisions on stimulus to the Office for Budgetary Responsibility (in the UK) which is also nominally independent, but a bit closer to the Treasury.

Re your claim that payments cannot be “instantaneously settled”, things like cheque and debit card payments are all settled under the existing system within about 48 hours as I understand it. E.g. if I make an £X debit card payment to your hairdressing salon, and I bank at bank A and you bank at bank B, then within 48 hours, £X will be shifted from A’s account at the central bank to B’s account at the central bank (assuming to keep things ultra simple that there are no other payments between all commercial banks on those two days).

Still on transaction departments / accounts and re your suggestion that commercial banks would need overdraft facilities at the central bank, that’s highly unlikely. Transaction departments don’t do loans and in that regard they’re like the UK savings bank National Savings and Investments. I.e. the balance in customers’ accounts at transaction departments is always positive, with the balance on a few accounts occasionally dropping to zero. Ergo transaction departments’ balance at the central bank would always be positive. So no need for overdrafts.

Now for PM’s investment accounts (or in the case of Kotlikoff’s system, non-money market mutual funds).

They accept base money from customers who want to buy into a particular accounts / funds. Their balance at the CB is at that stage positive. They then buy shares in stock exchange corporations or lend to mortgagors depending on what customers want their money put into. As long as those investment account / mutual fund departments of banks don’t spend more on stock exchange investments or dole out more to mortgagors than they actually have in the kitty, then again, they’d have no need for overdraft facilities at the CB.

However, there’d be no harm in the CB offering short term overdrafts at penalty rates for mutual funds / investment account departments which made a mistake, and paid out too much. That would be much like my relationship with my bank: I have no formal overdraft arrangement, but if I make a mistake (which happens once every five years or so) and write a cheque for too much, the bank honours it and sends me a rude letter and charges me about 50% interest. That’s OK by me. I made a mistake, so I pay.

Bill Mitchell says “I do not support frameworks where key economic decisions are handed to an essentially unaccountable body which then constrain the Parliament we elect to be our agents.” I agree with you Bill.

BTW, I can’t believe the rudeness of people who bombard Bill’s email, business or personal. If one does not know Bill personally or professionally, anything one has to say in MMT or economic debate can be posted in this blog. I myself have posted items which Bill has disagreed with (as well as items he has agreed with or simply not commented on). But to bombard him with unsolicited emails (especially insulting ones) is simply a very poor reflection on the sender.

There is curious lack of discussion among mainstream economist about what they think prevents government from funding itself. Because if it is this “money multiplier” model, it is easy to device solutions that would solve its supposed problems. If government would simply regulate the banks so that they would be allowed to expand their balance sheets by X percent a year, the supposed dangers of reserve buildups would go away.

Why isn’t any mainstream economist proposing this small regulatory change, so harmless that 99% of people never even would notice, when alternative is completely dysfunctional economy with mass suffering?

Some of you (only a few) might be wondering why your comments on these two blogs never appeared. As I indicated in the initial post, I do not intend to allow links to positive money sites on my blog. I find no value in a comment that says – “You are wrong Bill, please read … http:// some link to a PM site or another”.

I do not consider these sites to be an authority on anything I would want to promote and I would only link to them if by critiquing them that my own agenda was advanced. That is, in part, why I used the Iceland paper, which is a static resource.

I apologise for wasting your efforts, which I appreciate. That is why I put the warning up in the first paragraph of Part I of the two-part series on Iceland’s proposal.

This comment from Neil Wilson explains why it is a bad idea:
The main issue of course is that loans always create deposits and banks expand debt in the usual fashion. If you want to call them something else and deny their existence then that is fine but they never go away!

Very simply, Person A comes in for a 25 year loan. While that is being processed, the funding department secures funds from Person B on a seven day term and issues an investment account. That swaps funds from the Transaction Account to the bank’s Investment Account.

The loan is approved and the funds are swapped from the bank’s Investment Account to Person A’s Transaction Account. Person A then pays Person B for some real assets. Person B has the funds back in their Transaction Account and holds a seven day bond as well.

The seven day funds are a deposit – created by the loan request.

Seven days later Person B asks for their money back and there is a liquidity crisis. :)

It’s simplistic, but the presence of maturity transformation means that there will be a liquidity or solvency crisis at some point. It’s just a mistake of analysis of the weaknesses of the current system to presume anything else.

In the current system anybody holding above the deposit protection limit is similarly a ‘senior bond holder’, and we can see from the machinations in Cyprus that is causing all sorts of fun.

Bear in mind that in the UK there is already a ‘safe harbour’ option for individuals. It’s called ‘National Savings and Investments’. 1.5% interest up to £2 million.

I see the proposals as increasing the cost of mortgages, eliminating free banking, rotting away pensioner’s nest eggs (either take risk or watch your nest egg rot away with inflation) and increasing the cost of working capital loans to businesses while championing a system that will essentially deliver more tax cuts to rich people funding the lobbying process.

There’s clearly an ideology backing the proposals. There is just no need to throw the baby out with the bathwater like this.

The current system is slanted towards debt and power in the hands of private banks. These proposals slant the system towards equity and power in the hands of the wealthy. The money the banks currently put into the economy is intended to be given to the profit class via the virtual elimination of taxation. You will then have to go cap in hand to them rather than the banks if you want to do anything – and they will want part ownership in return for investment.

You only have to look at the people doing the funding and supporting of the organisation to see what the end game is. Even if the propaganda they put out tries to be ever so reasonable.

I much prefer the MMT approach where the central bank is brought back under the direct control of parliament and both lending and spending have equal distance access to the central bank.

As Randy’s paper on the subject suggests, the only service we are buying from private sector banks is their ability to capitalise and underwrite an income stream effectively – for which they should be paid. Whether that is done ‘outsourced’ via an interest rate markup or as a salary from a public investment bank is up for debate.

But ultimately these regulated banks are branches of the central bank and should behave as such. If that requires compulsory fitting of bowler hats, then so be it. It’s time for the central bank to stop being a shrinking violet and take charge of the distribution of its currency.

There are some good elements in the proposals though – particularly in the UK where we already have the APACS clearing system and the LINK ATM network. Therefore it wouldn’t be a particularly big leap to make all bank accounts operate centrally and allow banks to service them on an agency basis. That would make it much easier for people to move between ‘service portals’ – you wouldn’t even have to change your bank account number.

But I can’t support the overall proposals because of the underlying ideology.

I think the objectives of MMT and SMS are very similar. It doesn’t really matter who creates the money as long as (1) the right amount is created (not like present where private banks create as much as possible) (2) Enough money ends up in the productive economy and not in existing assets (unlike the present where the opposite occurs) (3) Sovereign governments are not required to borrow money at interest which they could create themselves for free (4) More money can be supplied to the productive economy to foster productive growth without anyone having to go into debt. (It is not necessary for a country to “rent” its money supply from banks). How to achieve these objectives are all details.
You may “not support frameworks where key economic decisions are handed to an essentially unaccountable body which then constrain the Parliament we elect to be our agents”, but I think you should in this case. Given the pork barrel politics we have already where citizens are squeezed to produce surpluses and those surpluses are spent buying votes in election year, separation of who creates and who spends the money is a sensible step. It is also much simpler than trying to solve the problem by “improving political processes”, although we should do that as well. Surely if you believe tight regulation can effectively control banks then regulation could also effectively control the MMC.
The other benefit of SMS is its simplicity. SMS is easy to read and understand. It seems to be an easier reform to achieve politically than what you are proposing. If we are really interested in change actually happening those factors need to be taken into account.
One concern I share with you about SMS is that interest rates might increase. I read arguments that they likely won’t but I am unsure.